[Federal Register Volume 75, Number 85 (Tuesday, May 4, 2010)]
[Notices]
[Pages 23704-23710]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-10304]
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COMMODITY FUTURES TRADING COMMISSION
Order Finding That the NWP Rockies Financial Basis Contract
Traded on the IntercontinentalExchange, Inc., Performs a Significant
Price Discovery Function
AGENCY: Commodity Futures Trading Commission.
ACTION: Final order.
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SUMMARY: On October 22, 2009, the Commodity Futures Trading Commission
(``CFTC'' or ``Commission'') published for comment in the Federal
Register \1\ a notice of its intent to undertake a determination
whether the NWP \2\ Rockies Financial Basis (``NWR'') contract traded
on the IntercontinentalExchange, Inc. (``ICE''), an exempt commercial
market (``ECM'') under sections 2(h)(3)-(5) of the Commodity Exchange
Act (``CEA'' or the ``Act''), performs a significant price discovery
function pursuant to section 2(h)(7) of the CEA. The Commission
undertook this review based upon an initial evaluation of information
and data provided by ICE as well as other available information. The
Commission has reviewed the entire record in this matter, including all
comments received, and has determined to issue an order finding that
the NWR contract performs a significant price discovery function.
Authority for this action is found in section 2(h)(7) of the CEA and
Commission rule 36.3(c) promulgated thereunder.
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\1\ 74 FR 54550 (October 22, 2009).
\2\ The acronym ``NWP'' indicates the Northwest Pipeline.
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DATES: Effective date: April 28, 2010.
FOR FURTHER INFORMATION CONTACT: Gregory K. Price, Industry Economist,
Division of Market Oversight, Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.
Telephone: (202) 418-5515. E-mail: [email protected]; Christa Lachenmayr,
Economist, Division of Market Oversight, same address. Telephone: (202)
418-5252. E-mail: [email protected]; or Susan Nathan, Senior Special
Counsel, Division of Market Oversight, same address. Telephone: (202)
418-5133. E-mail: [email protected].
SUPPLEMENTARY INFORMATION:
I. Introduction
The CFTC Reauthorization Act of 2008 (``Reauthorization Act'') \3\
significantly broadened the CFTC's regulatory authority with respect to
ECMs by creating, in section 2(h)(7) of the CEA, a new regulatory
category--ECMs on which significant price discovery contracts
(``SPDCs'') are traded--and treating ECMs in that category as
registered entities under the CEA.\4\ The legislation authorizes the
CFTC to designate an agreement, contract or transaction as a SPDC if
the Commission determines, under criteria established in section
2(h)(7), that it performs a significant price discovery function. When
the Commission makes such a determination, the ECM on which the SPDC is
traded must assume, with respect to that contract, all the
responsibilities and obligations of a registered entity under the Act
and Commission regulations, and must comply with nine core principles
established by new section 2(h)(7)(C).
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\3\ Incorporated as Title XIII of the Food, Conservation and
Energy Act of 2008, Public Law 110-246, 122 Stat. 1624 (June 18,
2008).
\4\ 7 U.S.C. 1a(29).
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On March 16, 2009, the CFTC promulgated final rules implementing
the provisions of the Reauthorization Act.\5\ As relevant here, rule
36.3 imposes increased information reporting requirements on ECMs to
assist the Commission in making prompt assessments whether particular
ECM contracts may be SPDCs. In addition to filing quarterly reports of
its contracts, an ECM must notify the Commission promptly concerning
any contract traded in reliance on the exemption in section 2(h)(3) of
the CEA that averaged five trades per day or more over the most recent
calendar quarter, and for which the exchange sells its price
information regarding the contract to market participants or industry
publications, or whose daily closing or settlement prices on 95 percent
or more of the days in the most recent quarter were within 2.5 percent
of the contemporaneously determined closing, settlement or other daily
prices of another contract.
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\5\ 74 FR 12178 (Mar. 23, 2009); these rules became effective on
April 22, 2009.
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Commission rule 36.3(c)(3) established the procedures by which the
Commission makes and announces its determination whether a particular
ECM contract serves a significant price discovery function. Under those
procedures, the Commission will publish notice in the Federal Register
that it intends to undertake an evaluation whether the specified
agreement, contract or transaction performs a significant price
discovery function and to receive written views, data and arguments
relevant to its determination from the ECM and other interested
persons. Upon the close of the comment period, the Commission will
consider, among other things, all relevant information regarding the
subject contract and issue an order announcing and explaining its
determination whether or not the contract is a SPDC. The issuance of an
affirmative order signals the effectiveness of the Commission's
regulatory authorities over an ECM with respect to a SPDC; at that time
such an ECM becomes subject to all provisions of the CEA applicable to
registered entities.\6\ The issuance of such an order also triggers the
obligations, requirements and timetables prescribed in Commission rule
36.3(c)(4).\7\
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\6\ Pub. L. 110-246 at 13203; Joint Explanatory Statement of the
Committee of Conference, H.R. Rep. No. 110-627, 110 Cong., 2d Sess.
978, 986 (Conference Committee Report). See also 73 FR 75888, 75894
(Dec. 12, 2008).
\7\ For an initial SPDC, ECMs have a grace period of 90 calendar
days from the issuance of a SPDC determination order to submit a
written demonstration of compliance with the applicable core
principles. For subsequent SPDCs, ECMs have a grace period of 30
calendar days to demonstrate core principle compliance.
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II. Notice of Intent To Undertake SPDC Determination
On October 22, 2009, the Commission published in the Federal
Register notice of its intent to undertake a
[[Page 23705]]
determination whether the NWR contract performs a significant price
discovery function and requested comment from interested parties.\8\
Comments were received from the Federal Energy Regulatory Commission
(``FERC''), Platts, Economists Incorporated (``EI'') and ICE.\9\ The
comment letters from FERC \10\ and Platts did not directly address the
issue of whether or not the NWR contract is a SPDC; ICE's and EI's
comments raised substantive issues with respect to the applicability of
section 2(h)(7) the NWR contract, generally asserting that the NWR
contract is not a SPDC as it does not meet the material liquidity,
material price reference and price linkage criteria for SPDC
determination. ICE's and EI's comments are more extensively discussed
below, as applicable.
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\8\ The Commission's Part 36 rules establish, among other
things, procedures by which the Commission makes and announces its
determination whether a specific ECM contract serves a significant
price discovery function. Under those procedures, the Commission
publishes a notice in the Federal Register that it intends to
undertake a determination whether a specified agreement, contract or
transaction performs a significant price discovery function and to
receive written data, views and arguments relevant to its
determination from the ECM and other interested persons.
\9\ FERC is an independent Federal regulatory agency that, among
other things, regulates the interstate transmission of natural gas,
oil and electricity. McGraw-Hill, through its division Platts,
compiles and calculates monthly natural gas price indices from
natural gas trade data submitted to Platts by energy marketers.
Platts includes those price indices in its monthly Inside FERC's Gas
Market Report (``Inside FERC''). ICE is an ECM, as noted above. EI
is an economic consulting firm with offices located in Washington,
DC, and San Francisco, CA. The comment letters are available on the
Commission's Web site: http://www.cftc.gov/lawandregulation/federalregister/federalregistercomments/2009/09-031.html.
\10\ FERC stated that the NWR contract is cash settled and does
not contemplate the actual physical delivery of natural gas.
Acccordingly, FERC expressed the opinion that a determination by the
Commission that a contract performs a significant price discovery
function ``would not appear to conflict with FERC's exclusive
jurisdiction under the Natural Gas Act (NGA) over certain sales of
natural gas in interstate commerce for resale or with its other
regulatory responsibilities under the NGA'' and further that ``FERC
staff will continue to monitor for any such conflict * * * [and]
advise the CFTC'' should any such potential conflict arise. CL 01.
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III. Section 2(h)(7) of the CEA
The Commission is directed by section 2(h)(7) of the CEA to
consider the following criteria in determining a contract's significant
price discovery function:
Price Linkage--the extent to which the agreement, contract
or transaction uses or otherwise relies on a daily or final settlement
price, or other major price parameter, of a contract or contracts
listed for trading on or subject to the rules of a designated contract
market (``DCM'') or derivatives transaction execution facility
(``DTEF''), or a SPDC traded on an electronic trading facility, to
value a position, transfer or convert a position, cash or financially
settle a position, or close out a position.
Arbitrage--the extent to which the price for the
agreement, contract or transaction is sufficiently related to the price
of a contract or contracts listed for trading on or subject to the
rules of a DCM or DTEF, or a SPDC traded on or subject to the rules of
an electronic trading facility, so as to permit market participants to
effectively arbitrage between the markets by simultaneously maintaining
positions or executing trades in the contracts on a frequent and
recurring basis.
Material price reference--the extent to which, on a
frequent and recurring basis, bids, offers or transactions in a
commodity are directly based on, or are determined by referencing or
consulting, the prices generated by agreements, contracts or
transactions being traded or executed on the electronic trading
facility.
Material liquidity--the extent to which the volume of
agreements, contracts or transactions in a commodity being traded on
the electronic trading facility is sufficient to have a material effect
on other agreements, contracts or transactions listed for trading on or
subject to the rules of a DCM, DTEF or electronic trading facility
operating in reliance on the exemption in section 2(h)(3).
Not all criteria must be present to support a determination that a
particular contract performs a significant price discovery function,
and one or more criteria may be inapplicable to a particular
contract.\11\ Moreover, the statutory language neither prioritizes the
criteria nor specifies the degree to which a SPDC must conform to the
various criteria. In Guidance issued in connection with the Part 36
rules governing ECMs with SPDCs, the Commission observed that these
criteria do not lend themselves to a mechanical checklist or formulaic
analysis. Accordingly, the Commission has indicated that in making its
determinations it will consider the circumstances under which the
presence of a particular criterion, or combination of criteria, would
be sufficient to support a SPDC determination.\12\ For example, for
contracts that are linked to other contracts or that may be arbitraged
with other contracts, the Commission will consider whether the price of
the potential SPDC moves in such harmony with the other contract that
the two markets essentially become interchangeable. This co-movement of
prices would be an indication that activity in the contract had reached
a level sufficient for the contract to perform a significant price
discovery function. In evaluating a contract's price discovery role as
a price reference, the Commission will consider whether cash market
participants are quoting bid or offer prices or entering into
transactions at prices that are set either explicitly or implicitly at
a differential to prices established for the contract.
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\11\ In its October 22, 2009, Federal Register release, the
Commission identified material price reference, price linkage and
material liquidity as the possible criteria for SPDC determination
of the NWR contract. Arbitrage was not identified as a possible
criterion and will not be discussed further in this document or the
associated Order.
\12\ 17 CFR Part 36, Appendix A.
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IV. Findings and Conclusions
a. The NWP Rockies Financial Basis (NWR) Contract and the SPDC Indicia
The ICE NWR contract is cash settled based on the difference
between the bidweek price of natural gas at the Northwest Pipeline's
Rockies hub for the month of delivery, as published in Platts' Inside
FERC's Gas Market Report, and the final settlement price for the New
York Mercantile Exchange's (``NYMEX's'') Henry Hub physically-delivered
natural gas futures contract for the same specified calendar month. The
Platts bidweek price, which is published monthly, is based on a survey
of cash market traders who voluntarily report to Platts data on fixed-
price transactions for physical delivery of natural gas at the Rockies
hub conducted during the last five business days of the month; such
bidweek transactions specify the delivery of natural gas on a uniform
basis throughout the following calendar month at the agreed upon rate.
The Platts bidweek index is published on the first business day of the
calendar month in which the natural gas is to be delivered. The size of
the NWR contract is 2,500 million British thermal units (``mmBtu''),
and the unit of trading is any multiple of 2,500 mmBtu. The NWR
contract is listed for up to 120 calendar months commencing with the
next calendar month.
The Henry Hub,\13\ which is located in Erath, Louisiana, is the
primary cash market trading and distribution center for natural gas in
the United States. It
[[Page 23706]]
also is the delivery point and pricing basis for the NYMEX's actively
traded, physically-delivered natural gas futures contract, which is the
most important pricing reference for natural gas in the United States.
The Henry Hub, which is operated by Sabine Pipe Line, LLC, serves as a
juncture for 13 different pipelines. These pipelines bring in natural
gas from fields in the Gulf Coast region and ship it to major
consumption centers along the East Coast and Midwest. The throughput
shipping capacity of the Henry Hub is 1.8 trillion mmBtu per day.
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\13\ The term ``hub'' refers to a juncture where two or more
natural gas pipelines are connected. Hubs also serve as pricing
points for natural gas at the particular locations.
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In addition to the Henry Hub, there are a number of other locations
where natural gas is traded. In 2008, there were 33 natural gas market
centers in North America.\14\ Some of the major trading centers include
Alberta, Northwest Rockies, Southern California border region and the
Houston Ship Channel. For locations that are directly connected to the
Henry Hub by one or more pipelines and where there typically is
adequate shipping capacity, the price at the other locations usually
directly tracks the price at the Henry Hub, adjusted for transportation
costs. However, at other locations that are not directly connected to
the Henry Hub or where shipping capacity is limited, the prices at
those locations often diverge from the Henry Hub price. Furthermore,
one local price may be significantly different than the price at
another location even though the two markets' respective distances from
the Henry Hub are the same. The reason for such pricing disparities is
that a given location may experience supply and demand factors that are
specific to that region, such as differences in pipeline shipping
capacity, unusually high or low demand for heating or cooling or supply
disruptions caused by severe weather. As a consequence, local natural
gas prices can differ from the Henry Hub price by more than the cost of
shipping and such price differences can vary in an unpredictable
manner.
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\14\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
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The Northwest Pipeline's Rockies hub is located in Wyoming, Utah
and Colorado.\15\ The Northwest Pipeline draws natural gas supplies
from the Rocky Mountain region and ships it along a 3,900-mile, bi-
directional transmission system to markets throughout the Rockies and
Pacific Northwest. The Opal market center, a trading region that
includes the Rockies hub, had an estimated throughput capacity of 1.5
billion cubic feet per day in 2008. Moreover, the number of pipeline
interconnections at the Opal market center was eight in 2008, up from
four interconnections in 2003. Lastly, the pipeline interconnection
capacity of the Opal market center in 2008 was six billion cubic feet
per day, which constituted an 86 percent increase over the pipeline
interconnection capacity in 2003.\16\ The Rockies hub is far removed
from the Henry Hub and is not directly connected to the Henry Hub by an
existing pipeline.
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\15\ The Rockies hub includes fixed-price gas delivered into
Northwest Pipeline's mainline in Wyoming, Utah and Colorado between
the Kemmerer and Moab stations. Deliveries at Ignacio, CO, and
elsewhere in zone MO (the area South of Moab, UT, into the San Juan
Mountains) are excluded. Transactions done at Opal, WY, and the
Muddy Creek compressor station (where the Northwest Pipeline
connects with Kern River Gas Transmission, Questar Pipeline and
Colorado Interstate Gas) are used because gas traded at those two
points often is not nominated into a specific pipeline.
\16\ See http://www.eia.doe.gov/pub/oil_gas/natural_gas/feature_articles/2009/ngmarketcenter/ngmarketcenter.pdf.
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The local price at the Rockies hub typically differs from the price
at the Henry Hub. Thus, the price of the Henry Hub physically-delivered
futures contract is an imperfect proxy for the Rockies price. Moreover,
exogenous factors, such as adverse weather, can cause the Rockies gas
price to differ from the Henry Hub price by an amount that is more or
less than the cost of shipping, making the NYMEX Henry Hub futures
contract even less precise as a hedging tool than desired by market
participants. Basis contracts \17\ allow traders to more accurately
discover prices at alternative locations and hedge price risk that is
associated with natural gas at such locations.\18\ In this regard, a
position at a local price for an alternative location can be
established by adding the appropriate basis swap position to a position
taken in the NYMEX physically-delivered Henry Hub contract (or in the
NYMEX or ICE Henry Hub look-alike contract, which cash settle based on
the NYMEX physically-delivered natural gas contract's final settlement
price).
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\17\ Basis contracts denote the difference in the price of
natural gas at a specified location minus the price of natural gas
at the Henry Hub. The differential can be either a positive or
negative value.
\18\ Commercial activity in natural gas basis swap contracts is
evidenced by large positions held by energy trading firms in the
comparable NYMEX ClearPort basis swap contract for the Rockies hub.
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In its October 22, 2009, Federal Register notice, the Commission
identified material price reference, price linkage and material
liquidity as the potential SPDC criteria applicable to the NWR
contract. Each of these criteria is discussed below.\19\
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\19\ As noted above, the Commission did not find an indication
of arbitrage in connection with this contract; accordingly, that
criterion was not discussed in reference to the NWR contract.
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1. Material Price Reference Criterion
The Commission's October 22, 2009, Federal Register notice
identified material price reference as a potential basis for a SPDC
determination with respect to this contract. The Commission considered
the fact that ICE sells its price data to market participants in a
number of different packages which vary in terms of the hubs covered,
time periods, and whether the data are daily only or historical. For
example, ICE offers the ``West Gas End of Day'' and ``OTC Gas End of
Day'' \20\ packages with access to all price data or just current
prices plus a selected number of months (i.e., 12, 24, 36 or 48 months)
of historical data. These two packages include price data for the NWR
contract.
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\20\ The OTC Gas End of Day dataset includes daily settlement
prices for natural gas contracts listed for all points in North
America.
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The Rockies hub is a major trading center for natural gas in the
United States. Traders, including producers, keep abreast of the prices
of the NWR contract when conducting cash deals. These traders look to a
competitively determined price as an indication of expected values of
natural gas at the Rockies hub when entering into cash market
transactions for natural gas, especially those trades that provide for
physical delivery in the future. Traders use the ICE NWR contract, as
well as other ICE basis swap contracts, to hedge cash market positions
and transactions--activities which enhance the NWR contract's price
discovery utility. The substantial volume of trading and open interest
in the NWR contract appears to attest to its use for this purpose.
While the NWR contract's settlement prices may not be the only factor
influencing spot and forward transactions, natural gas traders consider
the ICE price to be a critical factor in conducting OTC
transactions.\21\
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\21\ In addition to referencing ICE prices, natural gas market
firms participating in the Rockies market may rely on other cash
market quotes as well as industry publications and price indices
that are published by third-party price reporting firms when
entering into natural gas transactions.
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NYMEX lists a futures contract that is comparable to the ICE NWR
contract on its ClearPort platform. However, unlike the ICE contract,
none of the trades in the NYMEX Rockies Basis Swap (Platts IFERC)
futures contract are executed in NYMEX's centralized marketplace;
instead, all of the transactions originate as bilateral swaps that are
submitted to
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NYMEX for clearing. The daily settlement prices of the NYMEX Rockies
Basis Swap contract are influenced, in part, by the daily settlement
prices of the ICE NWR contract. This is because NYMEX determines the
daily settlement prices for its natural gas basis swap contracts
through a survey of cash market voice brokers. Voice brokers, in turn,
refer to the ICE NWR price, among other information, as an important
indicator as to where the market is trading. Therefore, the ICE NWR
price influences the settlement price for the NYMEX Rockies Basis Swap
contract. This is supported by an analysis of the daily settlement
prices for the NYMEX and ICE Rockies basis swap contracts. In this
regard, 98 percent of the daily settlement prices for the NYMEX Rockies
Basis Swap contract are within one standard deviation of the NWR
contract's settlement prices.
Lastly, the fact that the NWR contract does not meet the price
linkage criterion (discussed below) bolsters the argument for material
price reference. As noted above, the Henry Hub is the pricing reference
for natural gas in the United States. However, regional market
conditions may cause the price of natural gas in another area of the
country to diverge by more than the cost of transportation, thus making
the Henry Hub price an imperfect proxy for the local gas price. The
more variable the local natural gas price is, the more traders need to
accurately hedge their price risk. Basis swap contracts provide a means
of more accurately pricing natural gas at a location other than the
Henry Hub. An analysis of Rockies natural gas prices showed that all of
the observations were more than 2.5 percent different than the
contemporaneous Henry Hub prices. Specifically, the average Rockies
basis value between January 2008 and September 2009 was -$1.94 per
mmBtu with a variance of $1.88 per mmBtu.
i. Federal Register Comments
Both EI and ICE stated in their comment letters that the NWR
contract does not meet the material price reference criterion for SPDC
determination. ICE argued that the Commission appeared to base the case
that the NWR contract is potentially a SPDC on a disputable assertion.
In issuing its notice of intent to determine whether the NWR contract
is a SPDC, the CFTC cited a general conclusion in its ECM study ``that
certain market participants referred to ICE as a price discovery market
for certain natural gas contracts.'' ICE stated that, ``Basing a
material price reference determination on general statements made in a
two year old study does not seem to meet Congress' intent that the CFTC
use its considerable expertise to study the OTC markets.'' In response
to the above comment, the Commission notes that it cited the ECM
study's general finding that some ICE natural gas contracts appear to
be regarded as price discovery markets merely as an indicia that an
investigation of certain ICE contracts may be warranted, and was not
intended to serve as the sole basis for determining whether or not a
particular contract meets the material price reference criterion.
EI also stated that the NWR contract does not satisfy the material
price reference criterion. The commenter argued that other contracts
(physical or financial) are not indexed based on the ICE NWR contract
price, but rather are indexed based on the underlying cash price series
against which the NWR contract is settled. Thus, EI contends that the
underlying cash price series is the authentic reference price and not
the ICE contract itself. The Commission believes that this
interpretation of price reference is too limiting in that it only
considers the final index value on which the contract is cash settled
after trading ceases. Instead, the Commission believes that a cash-
settled derivatives contract could meet the price reference criteria if
market participants ``consult on a frequent and recurring basis'' the
derivatives contract when pricing forward, fixed-price commitments or
other cash-settled derivatives that seek to ``lock in'' a fixed price
for some future point in time to hedge against adverse price movements.
EI also argued that publication of price data in a package format
is a weak justification for material price reference. According to the
commenter, market participants generally do not purchase ICE data sets
for one contract's prices, so the fact that ICE sells the NWR prices as
part of a broad package is not conclusive evidence that market
participants are buying the ICE data sets because they find the NWR
prices have substantial value to them. The Commission notes that the
Rockies hub is a major natural gas trading point, and the NWR
contract's prices are well regarded in the industry as indicative of
the value of natural gas at the Rockies hub. Accordingly, the
Commission believes that it is reasonable to conclude that market
participants are purchasing the data packages that include the NWR
contract's prices in substantial part because the NWR contract prices
have particular value to them.
ii. Conclusion Regarding Material Price Reference
Based on the above, the Commission finds that the NWR contract
meets the material price reference criterion because it is referenced
and consulted on a frequent and recurring basis by cash market
participants when pricing transactions (direct evidence). Moreover, the
ECM sells the NWR contract's price data to market participants
(indirect evidence).
2. Price Linkage Criterion
In its October 22, 2009, Federal Register notice, the Commission
identified price linkage as a potential basis for a SPDC determination
with respect to the NWR contract. In this regard, the final settlement
of the NWR contract is based, in part, on the final settlement price of
the NYMEX's physically-delivered natural gas futures contract, where
the NYMEX is registered with the Commission as a DCM.
The Commission's Guidance on Significant Price Discovery Contracts
\22\ notes that a ``price-linked contract is a contract that relies on
a contract traded on another trading facility to settle, value or
otherwise offset the price-linked contract.'' Furthermore, the Guidance
notes that, ``[f]or a linked contract, the mere fact that a contract is
linked to another contract will not be sufficient to support a
determination that a contract performs a significant price discovery
function. To assess whether such a determination is warranted, the
Commission will examine the relationship between transaction prices of
the linked contract and the prices of the referenced contract. The
Commission believes that where material liquidity exists, prices for
the linked contract would be observed to be substantially the same as
or move substantially in conjunction with the prices of the referenced
contract.'' Furthermore, the Guidance proposes a threshold price
relationship such that prices of the ECM linked contract will fall
within a 2.5 percent price range for 95 percent of contemporaneously
determined closing, settlement or other daily prices over the most
recent quarter. Finally, the Commission also stated in the Guidance
that it would consider a linked contract that has a trading volume
equivalent to 5 percent of the volume of trading in the contract to
which it is linked to have sufficient volume potentially to be deemed a
SPDC (``minimum threshold'').
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\22\ Appendix A to the Part 36 rules.
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[[Page 23708]]
To assess whether the NWR contract meets the price linkage
criterion, Commission staff obtained price data from ICE and performed
the statistical tests cited above. Staff found that, while the Rockies
price is determined, in part, by the final settlement price of the
NYMEX physically-delivered natural gas futures contract (a DCM
contract), the Rockies hub price is not within 2.5 percent of the
settlement price of the corresponding NYMEX Henry Hub natural gas
futures contract on 95 percent or more of the days. Specifically,
during the third quarter of 2009, only 2.4 percent of the Rockies
natural gas prices derived from the ICE basis values were within 2.5
percent of the daily settlement price of the NYMEX Henry Hub futures
contract. In addition, staff found that the NWR contract fails to meet
the volume threshold requirement. In particular, the total trading
volume in the NYMEX physically-delivered natural gas contract during
the third quarter of 2009 was 14,022,963 contracts, with 5 percent of
that number being 701,148 contracts. The number of trades on the ICE
centralized market in the NWR contract during the same period was
279,905 contracts (equivalent to 69,976 NYMEX contracts, given the size
difference).\23\ Thus, centralized-market trades in the NWR contract
amounted to less than the minimum threshold.
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\23\ The NWR contract is one-quarter the size of the NYMEX Henry
Hub physically-delivered futures contract.
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Due to the specific criteria that a given ECM contract must meet to
fulfill the price linkage criterion, the requirements, for all intents
and purposes, exclude ECM contracts that are not near facsimiles of DCM
contracts even though the ECM contract may specifically use the
settlement price to value a position, which is the case of the NWR
contract. In this regard, an ECM contract that is priced and traded as
if it is a functional equivalent of a DCM contract likely will have a
price series that mirrors that of the corresponding DCM contract. In
contrast, for contracts that are not look-alikes of DCM contracts, it
is reasonable to expect that the two price series would be divergent.
While the Rockies hub and the Henry Hub are both supply centers, they
are located in two different areas of the United States. Moreover, the
Rockies hub is somewhat isolated and the two hubs are not directly
connected to each other. These differences contribute to the divergence
between the two price series and, as discussed above, increase the
likelihood that the ``basis'' contract is used for material price
reference.
i. Federal Register Comments
As noted above, ICE and EI addressed the question of whether the
NWR contract is a SPDC. EI noted that the NWR and NYMEX natural gas
contracts are not economically equivalent and that the NWR contract's
volume is too low to affect the NYMEX natural gas futures contract. ICE
opined that the NWR contract's trading volume is too low to affect the
price discovery process for the NYMEX natural gas futures contract. In
addition, ICE states that the NWR contract simply reflects a price
differential between the Rockies and the Henry Hub; ``there is no price
linkage as contemplated by Congress or the CFTC in its rulemaking.''
ii. Conclusion Regarding the Price Linkage Criterion
Based on the above, the Commission finds that the NWR contract does
not meet the price linkage criterion because it fails the price
relationship and volume tests provided for in the Commission's
Guidance.
3. Material Liquidity Criterion
To assess whether the NWR contract meets the material liquidity
criterion, the Commission first examined volume and open interest data
provided to it by ICE as a general measurement of the NWR market's size
and potential importance, and second performed a statistical analysis
to measure the effect that changes to NWR prices potentially may have
on prices for the NYMEX Henry Hub Natural Gas (a DCM contract), the ICE
PG&E Citygate Financial Basis contract (an ECM contract) and the Malin
Financial Basis contract (an ECM contract).\24\
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\24\ As noted above, the material liquidity criterion speaks to
the effect that transactions in the potential SPDC may have on
trading in ``agreements, contracts and transactions listed for
trading on or subject to the rules of a designated contract market,
a derivatives transaction execution facility, or an electronic
trading facility operating in reliance on the exemption in section
2(h)(3) of the Act.''
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The Commission's Guidance (Appendix A to Part 36) notes that
``[t]raditionally, objective measures of trading such as volume or open
interest have been used as measures of liquidity.'' In this regard, the
Commission in its October 22, 2009, Federal Register notice referred to
second quarter 2009 trading statistics that ICE had submitted for its
NWR contract. Based upon on a required quarterly filing made by ICE on
July 27, 2009, the total number of NWR trades executed on ICE's
electronic trading platform was 3,013 in the second quarter of 2009,
resulting in a daily average of 47.1 trades. During the same period,
the NWR contract had a total trading volume on ICE's electronic trading
platform of 276,187 contracts and an average daily trading volume of
4,315 contracts. Moreover, the open interest as of June 30, 2009, was
349,931 contracts, which included trades executed on ICE's electronic
trading platform, as well as trades executed off of ICE's electronic
trading platform and then brought to ICE for clearing.\25\
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\25\ ICE does not differentiate between open interest created by
a transaction executed on its trading platform versus that created
by a transaction executed off its trading platform. 74 FR 54550
(October 22, 2009).
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Subsequent to the October 22, 2009, Federal Register notice, ICE
submitted another quarterly notification filed on November 13,
2009,\26\ with updated trading statistics. Specifically, with respect
to its NWR contract, 2,950 separate trades occurred on its electronic
platform in the third quarter of 2009, resulting in a daily average of
44.7 trades. During the same period, the NWR contract had a total
trading volume on its electronic platform of 279,905 contracts (which
was an average of 4,241 contracts per day).\27\ As of September 30,
2009, open interest in the NWR contract was 345,683 contracts.\28\
Reported open interest included positions resulting from trades that
were executed on ICE's electronic platform, as well as trades that were
executed off of ICE's electronic platform and brought to ICE for
clearing.
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\26\ See Commission Rule 36.3(c)(2), 17 CFR 36.3(c)(2).
\27\ By way of comparison, the number of contracts traded in the
NWR contract is similar to that exhibited on a liquid futures market
and is roughly equivalent to the volume of trading for the Chicago
Mercantile Exchange Feeder Cattle futures contract during this
period.
\28\ By way of comparison, open interest in the NWR contract is
roughly equivalent to that in the Chicago Board of Trade's wheat
contract.
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In Appendix A to Part 36, the material liquidity criterion for SPDC
determination specifies that an ECM contract should have a material
effect on another contract. To measure the effect that the NWR contract
potentially could have on a DCM contract, or on another ECM contract,
Commission staff performed a statistical analysis \29\ using
[[Page 23709]]
daily settlement prices (between January 2, 2008, and September 30,
2009) for the NYMEX Henry Hub natural gas contract (a DCM contract) and
price levels for the Rockies, PG&E Citygate and Malin market
centers.\30\ The simulation results suggest that, on average over the
sample period, a one percent rise in the Rockies natural gas price
elicited a 0.254 percent to 0.276 percent increase in the PG&E Citygate
and Malin hub natural gas prices, and a 0.176 percent increase in the
NYMEX Henry Hub natural gas price.
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\29\ Specifically, Commission staff econometrically estimated a
vector autoregression model using daily natural gas price levels. A
vector autoregression model is an econometric model used to capture
the dependencies and interrelationships among multiple time series,
generalizing the univariate autoregression model. The estimated
model displays strong diagnostic evidence of statistical adequacy.
In particular, the model's impulse response function was shocked
with a one-time rise in Rockies price. The simulation results
suggest that, on average over the sample period, a one percent rise
in the Rockies natural gas price elicited a 0.176 percent increase
in the NYMEX Henry Hub price, as well as a 0.254 percent to 0.276
percent increase in the other two modeled natural gas prices. These
multipliers of response emerge with noticeable statistical strength
or significance. Based on such long run sample patterns, if the
Rockies price rises by 10 percent, then the price of NYMEX Henry Hub
natural gas futures contract, as well as those for the Alberta and
HSC hubs, each would rise by about 1.5 percent to 2.5 percent. The
relatively small magnitude of the multipliers likely reflects the
fact that the Rockies hub is isolated and not directly connected to
the Henry Hub.
\30\ Natural gas prices at the Rockies, PG&E Citygate and Malin
trading centers were obtained by adding the daily settlement prices
of ICE's NWP Rockies Financial Basis, PG&E Citygate Financial Basis
and Malin Financial Basis contracts, respectively, to the
contemporaneous daily settlement prices of the NYMEX Henry Hub
physically-delivered natural gas futures contract.
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i. Federal Register Comments
As noted above, ICE and EI addressed the question of whether the
NWR contract is a SPDC. ICE stated in its comment letter that the NWR
contract does not meet the material liquidity criterion for SPDC
determination for a number of reasons.
First, ICE opined that the Commission ``seems to have adopted a
five trade-per-day test to determine whether a contract is materially
liquid. It is worth noting that ICE originally suggested that the CFTC
use a five trades-per-day threshold as the basis for an ECM to report
trade data to the CFTC.'' In this regard, the Commission adopted a five
trades-per-day threshold as a reporting requirement to enable it to
``independently be aware of ECM contracts that may develop into SPDCs''
\31\ rather than solely relying upon an ECM on its own to identify any
such potential SPDCs to the Commission. Thus, any contract that meets
this threshold may be subject to scrutiny as a potential SPDC; the
threshold is not intended to define liquidity in a broader sense. As
noted above, the Commission is basing a finding of material liquidity
for the ICE NWR contract, in part, on the fact that there were nearly
45 trades per day on average in the NWR contract during the third
quarter of 2009, which was far more than the five trades-per-day
threshold that is cited in the ICE comment. In addition, the Commission
notes that the number of contracts per transaction in the NWR contract
is high (approximately 95 contracts per transaction) and thus, as
noted, trading volume (measured in contract units) is substantial. The
NWR contract also has substantial open interest.
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\31\ 73 FR 75892 (December 12, 2008).
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ICE also stated that ``the statistics [provided by ICE] have been
misinterpreted and misapplied.'' In particular, ICE stated that the
volume figures used in the Commission's analysis (cited above)
``include trades made in all 120 months of each contract'' as well as
in strips of contract months, and a ``more appropriate method of
determining liquidity is to examine the activity in a single traded
month or strip of a given contract.'' Furthermore, ICE noted that for
the NWR contract, ``28% of the trades actually executed in the ICE
platform occurred in the single most liquid, usually prompt, month of
the contract.'' EI also expressed its belief that the contract months
should be evaluated individually.
It is the Commission's opinion that liquidity, as it pertains to
the NWR contract, is typically a function of trading activity in
particular lead months and, given sufficient liquidity in such months,
the NWR contract itself would be considered liquid. ICE's analysis of
its own trade data confirms this to be the case for the NWR contract,
and thus, the Commission believes that it applied the statistical data
cited above in an appropriate manner for gauging material liquidity.
In addition, ICE and EI both stated that the trades-per-day
statistics that it provided to the Commission in its quarterly filing
and which are cited above includes 2(h)(1) transactions, which were not
completed on the electronic trading platform and should not be
considered in the SPDC determination process. The Commission staff
asked ICE to review the data it sent in its quarterly filings. In
response, ICE confirmed that the volume data it provided and which the
Commission cited in its October 22, 2009, Federal Register notice, as
well as the additional volume information it cites above, includes only
transaction data executed on ICE's electronic trading platform.\32\ The
Commission acknowledges that the open interest information it cites
above includes transactions made off the ICE platform. However, once
open interest is created, there is no way for ICE to differentiate
between ``on-exchange'' versus ``off-exchange'' created positions, and
all such positions are fungible with one another and may be offset in
any way agreeable to the position holder regardless of how the position
was initially created.
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\32\ Supplemental data supplied by ICE confirmed that block
trades in the third quarter of 2009 were in addition to the trades
that were conducted on the electronic platform; block trades
comprised 44.4 percent of all transactions in the NWR contract.
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ii. Conclusion Regarding Material Liquidity
Based on the above, the Commission concludes that the NWR contract
meets the material liquidity criterion in that there is sufficient
trading activity in the NWR contract to have a material effect on
``other agreements, contracts or transactions listed for trading on or
subject to the rules of a designated contract market * * * or an
electronic trading facility operating in reliance on the exemption in
section 2(h)(3) of the Act'' (that is, an ECM).
4. Overall Conclusion
After considering the entire record in this matter, including the
comments received, the Commission has determined that the NWR contract
performs a significant price discovery function under two of the four
criteria established in section 2(h)(7) of the CEA. Although the
Commission has determined that the NWR contract does not meet the price
linkage criterion at this time, the Commission has determined that the
NWR contract does meet both the material liquidity and material price
reference criteria. Accordingly, the Commission will issue the attached
Order declaring that the NWR contract is a SPDC.
Issuance of this Order signals the immediate effectiveness of the
Commission's authorities with respect to ICE as a registered entity in
connection with its NWR contract,\33\ and triggers the obligations,
requirements--both procedural and substantive--and timetables
prescribed in Commission rule 36.3(c)(4) for ECMs.
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\33\ See 73 FR 75888, 75893 (Dec. 12, 2008).
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V. Related Matters
a. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \34\ imposes certain
requirements on Federal agencies, including the Commission, in
connection with their conducting or sponsoring any collection of
information as defined by the PRA. Certain provisions of Commission
rule 36.3 impose new regulatory and reporting requirements on ECMs,
resulting in information collection requirements within the meaning of
the PRA. OMB previously has approved and
[[Page 23710]]
assigned OMB control number 3038-0060 to this collection of
information.
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\34\ 44 U.S.C. 3507(d).
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b. Cost-Benefit Analysis
Section 15(a) of the CEA \35\ requires the Commission to consider
the costs and benefits of its actions before issuing an order under the
Act. By its terms, section 15(a) does not require the Commission to
quantify the costs and benefits of an order or to determine whether the
benefits of the order outweigh its costs; rather, it requires that the
Commission ``consider'' the costs and benefits of its actions. Section
15(a) further specifies that the costs and benefits shall be evaluated
in light of five broad areas of market and public concern: (1)
Protection of market participants and the public; (2) efficiency,
competitiveness and financial integrity of futures markets; (3) price
discovery; (4) sound risk management practices; and (5) other public
interest considerations. The Commission may in its discretion give
greater weight to any one of the five enumerated areas and could in its
discretion determine that, notwithstanding its costs, a particular
order is necessary or appropriate to protect the public interest or to
effectuate any of the provisions or accomplish any of the purposes of
the Act. The Commission has considered the costs and benefits in light
of the specific provisions of section 15(a) of the Act and has
concluded that the Order, required by Congress to strengthen federal
oversight of exempt commercial markets and to prevent market
manipulation, is necessary and appropriate to accomplish the purposes
of section 2(h)(7) of the Act.
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\35\ 7 U.S.C. 19(a).
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When a futures contract begins to serve a significant price
discovery function, that contract, and the ECM on which it is traded,
warrants increased oversight to deter and prevent price manipulation or
other disruptions to market integrity, both on the ECM itself and in
any related futures contracts trading on DCMs. An Order finding that a
particular contract is a SPDC triggers this increased oversight and
imposes obligations on the ECM calculated to accomplish this goal. The
increased oversight engendered by the issue of a SPDC Order increases
transparency and helps to ensure fair competition among ECMs and DCMs
trading similar products and competing for the same business. Moreover,
the ECM on which the SPDC is traded must assume, with respect to that
contract, all the responsibilities and obligations of a registered
entity under the CEA and Commission regulations. Additionally, the ECM
must comply with nine core principles established by section 2(h)(7) of
the Act--including the obligation to establish position limits and/or
accountability standards for the SPDC. Section 4(i) of the CEA
authorizes the Commission to require reports for SPDCs listed on ECMs.
These increased responsibilities, along with the CFTC's increased
regulatory authority, subject the ECM's risk management practices to
the Commission's supervision and oversight and generally enhance the
financial integrity of the markets.
c. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \36\ requires that
agencies consider the impact of their rules on small businesses. The
requirements of CEA section 2(h)(7) and the Part 36 rules affect ECMs.
The Commission previously has determined that ECMs are not small
entities for purposes of the RFA.\37\ Accordingly, the Chairman, on
behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b)
that this Order, taken in connection with section 2(h)(7) of the Act
and the Part 36 rules, will not have a significant impact on a
substantial number of small entities.
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\36\ 5 U.S.C. 601 et seq.
\37\ 66 FR 42256, 42268 (Aug. 10, 2001).
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VI. Order
a. Order Relating to the ICE NWP Rockies Financial Basis Contract
After considering the complete record in this matter, including the
comment letters received in response to its request for comments, the
Commission has determined to issue the following:
The Commission, pursuant to its authority under section 2(h)(7) of
the Act, hereby determines that the NWP Rockies Financial Basis
contract, traded on the IntercontinentalExchange, Inc., satisfies the
statutory material liquidity and material price reference criteria for
significant price discovery contracts. Consistent with this
determination, and effective immediately, the IntercontinentalExchange,
Inc., must comply with, with respect to the NWP Rockies Financial Basis
contract, the nine core principles established by new section
2(h)(7)(C). Additionally, the IntercontinentalExchange, Inc., shall be
and is considered a registered entity \38\ with respect to the NWP
Rockies Financial Basis contract and is subject to all the provisions
of the Commodity Exchange Act applicable to registered entities.
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\38\ 7 U.S.C. 1a(29).
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Further, the obligations, requirements and timetables prescribed in
Commission rule 36.3(c)(4) governing core principle compliance by the
IntercontinentalExchange, Inc., commence with the issuance of this
Order.\39\
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\39\ Because ICE already lists for trading a contract (i.e., the
Henry Financial LD1 Fixed Price contract) that was previously
declared by the Commission to be a SPDC, ICE must submit a written
demonstration of compliance with the Core Principles within 30
calendar days of the date of this Order. 17 CFR 36.3(c)(4).
Issued in Washington, DC on April 28, 2010, by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. 2010-10304 Filed 5-3-10; 8:45 am]
BILLING CODE P